Bank deposits are the one true friend of a middle class Indian and any threat to their safety is terribly upsetting. The government will introduce a new bill in Parliament in the winter session called the Financial Resolution and Deposit Insurance (FRDI) bill. One section of this bill is causing bank depositors to fear for the safety of their money. I read the bill over the weekend and this is my understanding of what the aim of the bill is and what it means for you.

The FRDI Bill aims to put in place an early warning system for financial firms. It covers banks, insurance companies, payment systems, stock exchanges, and some others are financial firms. When banks fail who gets hurt? Depositors like you and me. If an insurance company fails, again it is us, the retail consumers who get hurt. If a biscuit maker or a noodle company or a car company fails, we may get hurt due to reduced choices, but there is no financial implication (unless you are an investor), but when a financial firm fails, we can lose our money that has been entrusted to the firm. That is why we need a different set of rules for financial firms.

The FRDI Bill aims to set up an entity called the Resolution Corporation (RC) that insures bank deposits. Today your bank deposits are insured to the tune of Rs 1 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC). The RC will also insure bank deposits and the insured limit will be set in consultation with the RBI. The last revision to the insured deposit amount was in 1993 and the limit is likely to go up to inflation index it, rather than down.

It also puts in place rules that will classify financial firms into five categories based on their risk of failure: low, moderate, material, imminent and critical risk to viability. If a financial firm gets classified as ‘material’ or ‘imminent’ risk to failure, there is a process in place that gives the firm and the system time to either recover from the illness, or if it is going towards the terminal stage, to allow the system to prepare for failure. If the firm gets classified as ‘critical’ risk, then the RC has several ways in which it can resolve it. It takes over the administration of the firm on the day it is classified as ‘critical’ and it can use any one or more of the five routes to resolve the crisis. One, it can transfer assets and liabilities of the firm to another firm. Two, it can merge the firm or put it up for acquisition. Three, it can create a bridge financial firm to take over the assets, liabilities and management of the failing firm. Four, it can use the bail-in provision or convert the debt of the firm. Five, it can liquidate the firm.

It is the bail-in clause that is causing all the panic in the minds of the depositors. Will my deposits be used to reduce the liability of the bank? No, you do not need to worry that your deposits will be lost in a bail-in. Your deposits will be insured, just as they are today and there is an additional protection for depositors because the bail-in can be invoked, and your deposits be lost, only if you have given your consent for this to the bank when you signed the deposit forms.

You need to remember that the bail-in clause is just one of the prescribed methods that the RC can use. If the system in place is robust, few firms will actually reach a critical stage of risk. The approach that the FRDI bill takes should make you actually feel safer. Instead of an ad hoc personality driven approach, India will now have a rule of law based approach to financial firms

The FRDI debate finally comes down on the intent of the government. It will be political suicide for a government that allows bank depositors to lose their money due to bank failure, even beyond the insured amounts. Public sector banks have just got recapitalised to prevent bank failure. That option remains with the government even after the FRDI Act comes into being. As taxpayers we should worry about the impact of such bail-outs that happen when financial firms fail without a process in place, on how our taxes are being used to pay for the inefficiency of banks that made loans they cannot recover. A well-defined system that makes banks more accountable and gives an early warning of ill health is progress, without exposing our deposits to more risk than they face today is progress.

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